A Monetary Policy to Boost
Regional Competitiveness:
The CFA Franc Zone

by Marc Adlam, Center for International Private Enterprise

In Francophone Africa, a unique monetary union known as the Communauté Financière Africaine, or CFA, links a group of 14 countries that have pegged their CFA franc to the French franc. The countries in the CFA franc zone-Senegal, Mali, Niger, Chad, Côte d'Ivoire, Burkina Faso, Togo, Benin, Cameroon, the Central African Republic, Equitorial Guinea, Gabon and Congo-face a dilemma when evaluating the competitive merits of their monetary union. On the one hand, this form of integration has enhanced trade and factor mobility among member countries and has provided a measure of monetary stability. On the other hand, the link to the French franc has made the exports of member countries more expensive relative to some of their competitors. Either way, one thing is clear: Although the CFA union has allowed its member states to avoid devaluation and keep the same fixed exchange rate parity for a stunning 45 years, this arrangement cannot continue indefinitely.

In fact, the impending anxiety over devaluation in CFA countries has made capital flight a much greater problem than ever before. Some of the affluent class from the CFA zone have been seen flying to France with entire suitcases full of CFA francs. They hope to convert the CFA francs into French francs to take advantage of their current purchasing power.

At first glance, the franc zone may appear to be a vestige of French colonialism, a long-outdated means by which France still exerts a degree of economic control over its former subjects. This, however, is not the case. In fact, the volume of the zone's international trade with France has actually decreased over the last 20 years, from almost 50 percent to about 30 percent of the Zone's total trade. In addition, membership in the zone is completely voluntary on the part of the member countries.

The French government has stood behind the CFA franc since 1948, guaranteeing convertibility at a rate of one French franc per 50 CFA francs. It would take a unanimous decision of all the member countries, as well as France, to change this fixed rate. The CFA zone features two central banks: the Union Monétaire de l'Ouest Africaine (based in Dakar, Senegal) and the Banque des Etats de l'Afrique Central (based in Yaoundé, Cameroon). Thus, in addition to being a monetary standard, the CFA zone forms two distinct, regional currency unions that enable their citizens to use the CFA franc for cross-border trade. Under a series of Africanization reforms implemented in 1974, France conceded greater autonomy to the two local central banks, but retained full veto power.

Why Belong to the CFA Zone?

A major benefit of participating in the CFA zone stems from the mechanisms designed to instill fiscal and monetary prudence among member governments, thereby guarding against unbridled public spending and runaway inflation. The central bank of each participating country is required to deposit at least 65 percent of its foreign currency reserves in the French Treasury. Here it goes into a special operations account, from which that country may borrow or collect interest. Naturally, as with any such bank account, countries are paid interest on any credit balances they maintain, just as they are charged interest on any overdrafts they make.

By limiting the amount of funds available for borrowing, the French Treasury limits the money supply and, at least theoretically, limits government spending by member countries. In addition, member country central banks borrow from the two CFA central banks to meet their budgetary requirements. In turn, the CFA central banks borrow from the French central bank. France has seen to it that neither of the two CFA central banks has run a negative account balance, again providing a cushion against excessive borrowing.

Another deflationary measure built into the Zone is the limit placed on credit, whereby the central banks are not allowed to provide a country with funding in excess of 20 percent of governmental revenues from the previous year. Still, continued borrowing to finance deficits has outstripped savings and led to an inflated CFA franc.

The net effect is that France ends up financing any budgetary overruns made by the African nations. On the one hand, this gives France the acknowledged right to share its budgetary experience and help the African nations set fiscal goals. But on the other hand, it still puts a great financial burden on France's treasury. The problem has become so acute that estimates from 1988 alone showed France doling out some 20 billion French francs to support the zone's parity.

The Zone's Problem with Competitiveness

Since the mid-1980s, Francophone Africa has been simmering in an economic crisis of enormous proportions. The reasons are various, complex and interrelated. The first and most obvious reason has been a drastic drop in commodity prices. Since none of these countries supports a large manufacturing sector, they rely on the exports of basic goods like cotton, coffee and cocoa to drive their economies. At the same time, the CFA countries have found that even when the weather cooperates and the productive yields are good, it has become increasingly difficult to penetrate saturated Western markets. As a result, the bottom has fallen out of primary commodity sales causing huge current account deficits in Francophone Africa.

Because it is pegged to the French franc, and because the franc has appreciated considerably relative to the US dollar since 1986, the strength of the CFA franc has caused the exports of member countries to become prohibitively expensive, making it almost impossible for local products to compete on the world market. One frequently cited example comes from Cameroon in late 1987, where local rice was three times as expensive on the world market as its counterpart Asian rice. The result is that, without devaluation, CFA governments must reduce the prices paid to producers, and an increasing number of producers are responding by halting supply.

The overvalued CFA franc also damages local industry. Since firms cannot compete with cheap imports, many of them simply go bankrupt. Only with the help of tariffs and other trade barriers are the remaining industries able to survive. However, these trade barriers distort market signals and constrain economic efficiency. Although it is easy for outsiders to see the distorting effects, business people inside the country are obliged to work within the status quo. That is why investment is occurring only in protected industries and monopolies.

Further aggravating the problem, a number of neighboring African countries-including among others Nigeria, Ghana and Zaire-decided to devalue their own currencies and adopt a floating exchange rate system. These devaluations have created a lucrative business for smugglers bringing goods into CFA countries to take advantage of their overvalued currency. The CFA countries themselves have tried implementing all manner of tariffs and border controls to stem this flow, but have met with little success in squashing the fraudulent trade. As a result, for example, merchandise worth over 12 billion CFA was traded between Benin and Nigeria in the early 1980s. In addition, according to the World Bank, as the smuggling problem has increased, as much as 90 percent of relevant imports manage to escape their full rate of taxation.

The Risks of Devaluation

In recent years, as the competitiveness of CFA countries has slipped and their exports have plummeted, the debate over devaluation has grown more heated. However, devaluation carries risks and, by itself, does not provide for instant competitiveness on world markets. A major drawback involves the threat of inflation resulting from the rise in nominal prices, especially for imports. Also, the industrial sector can suffer, particularly if it is dependent on foreign inputs like spare parts or energy. Another downside to devaluation is the anxiety it causes among investors, who are leery of inflationary environments because it creates greater exposure to currency risk.

This is why roughly two-thirds of developing countries seek at least some degree of stability by pegging their currency to another, more established world currency. Govern-ment officials strive to find the proper mix of economic policies that will keep their currency on balance with other key currencies. The effect of stabilizing their exchange rate is to increase public confidence in their economy, thus encouraging growth and investment. This is exactly what Domingo Cavallo, Argentina's Minister of Economics, has managed to do with the Argentine peso, pegging it at a fixed rate to the American dollar and backing it with foreign reserves. (See Cavallo interview, page 7)

Developing countries commonly adjust the value of their currency in response to market forces, such as different rates of inflation with respect to the key currency countries. Devaluation is also commonly employed as a way of enhancing competitiveness, based on the theory that a weaker currency makes exports less expensive and, therefore, more competitive.

The Role of Democratization

In the final analysis it is the exporters, primarily farmers, who are really hurt by the overvalued currency in these commodity-driven economies. However, political factors are impeding their ability to obtain corrective action: Farmers are largely excluded from policy making in these countries.

Political power is concentrated in the cities, among civil servants and other upper classes, who are better organized, located closer to the centers of power, and (most importantly) who vote. Indeed, the CFA states have been called "civil service regimes," because they possess oversized public sectors staffed by a small percentage of the population who directly benefit from the status quo. These civil servants live comfortably, even though their purchasing power is only artificially strengthened through the present currency system.

Because of this political situation, there is a huge disparity in income between the rural and urban working classes. However, democratic change will undoubtedly allow for greater, more effective rural representation. Once this happens, farmers will seek to combat the narrow urban base of political support in favor of maintaining the current CFA system.

There are clearly no easy solutions to the current monetary crisis in Francophone West Africa. Certain political, social and economic groups within those countries stand to lose economic power if the CFA franc is devalued while other groups will not prosper if change does not take place. Democratization, however, will serve to balance these decisions by allowing all groups to actively participate in the policy making process and make politicians more responsible to constituents for the decisions they make.

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